Corporate Tax Cut May Not Lead To High Fiscal Deficit

After finance minister Nirmala Sitharaman announced cutting corporate tax rate down to 22 per cent, there was a wide speculation that it may push the fiscal deficit to over 4 per cent of the gross domestic product or GDP. 

Considering that the finance minister had said the move would cost the government around Rs 1.45 lakh crore in terms of revenue foregone, which translates to 0.7 per cent of the GDP, it meant the deficit would go up to 4.2 per cent.  However, the actual impact may be much lower.

Lowering tax rate often results in a better compliance, leading to a higher tax collection. This could mean that the actual revenue foregone owing to tax rate cut may be lower than Rs 1.45 lakh crore. 

As per a report by Fitch Group’s India Ratings and Research, “Reduction in corporate tax has been a long-standing demand of the corporate sector, which could lead to a significant change in business sentiment, and in turn could result in expansion in business activities and investment, thus helping government garner higher taxes.” 

Also, contrary to the perception that the effective tax rate for corporates would come down from existing 35 per cent to 25 per cent, data shows that the average effective tax rate for such companies had actually amounted to 29.5 per cent earlier. So the impact on revenue may be lesser than assumed.  

Another research report by Emkay Global clarifies,“Although the headline corporate tax level has been dropped from 35 per cent to 25 per cent, including surcharge and cess, the effective tax rate for large corporate (at present) is lower - in the range of 22-23 per cent. This is mainly due to tax incentives, exemptions, and certain capex and investment allowances that companies enjoy... As a result, the tax rate calculation would not be the same as the headline rate.” 

However, even considering the loss of Rs 1.45 lakh crore, a major portion of the tax foregone will come back to the government through the dividends that public sector firms may announce as they too pay lower taxes. And since the tax foregone will also be shared almost equally between the Centre and states, the impact on Centre’s fiscal deficit would be limited as well. With these factors taken into account, the fiscal deficit may go up by only 0.2-0.3 per cent instead of  0.7 per cent, as assumed.